- Securities and Exchange Commission (SEC) imposes
temporary ban on "naked" short selling in 19
designated stocks; says measure aims to stop
rumour-mongering
- SEC chairman attacks "short and distort"
tactics; warns of new rules against short sellers in broader
market
- US Hedge Fund Association slams SEC move while top US law
firm calls for more aggressive action against short
sellers
One month after the FSA introduced restrictions on short selling of shares in the UK, the US SEC, announced a temporary ban on so-called "naked" short selling, a practice that involves traders selling stocks short without borrowing the stock beforehand. The ban was applied to stocks of 19 companies including major US investment banks such as Goldman Sachs and Merrill Lynch and the US mortgage companies Freddie Mac and Fannie Mae.
In an emergency order on 15 July, the SEC described its action as an attempt to tackle the problem of false rumours and the threat of panic selling, which it said could be exacerbated by naked short selling - because it enables traders to short the same stock multiple times and artificially and rapidly drive down the price of securities.
In particular, the SEC cited the recent Bear Stearns collapse, which it said has shown how rumours could quickly erode confidence in a firm, and the case of a trader who was recently charged by the SEC with securities fraud for intentionally spreading a false rumour about Blackstone's acquisition of Alliance Data Systems Corp, which forced the price of its stock to plummet.
According to the SEC, imposing the ban would provide "powerful disincentives to those who might otherwise engage in illegal market manipulation through the dissemination of false rumours" - what SEC chairman Christopher Cox described as "distort and short manipulation."
The ban was applied from 19 July to 12 August during which time anyone shorting the designated stock had to "borrow or arrange to borrow" the security before shorting the stock. Extending the order on 29 July, Cox also warned the SEC would continue "exploring other remedies for the broader marketplace to further protect investors from 'distort and short' artists."
Responding to the SEC's move, the Managed Funds Association (MFA) - the top US hedge fund association - and the Coalition of Private Investment Companies (CPIC), issued a strongly worded statement denouncing the SEC measure as a restriction that would "distort the fundamentals that drive fair market prices."
The two bodies also rejected what they called a "mysterious conspiracy" to artificially drive down stock prices. In fact, the MFA / CPIC praised short sellers as being "often the first to uncover and reveal financial misdeeds....turning over the rocks that many in the market would prefer left untouched" and "pointing out, on occasion, that the emperor has no clothes."
They also claimed criticism of short selling was an excuse used by corporate management teams to conceal "the impact of their own poor risk management and business and investment decisions", and that the SEC was artificially protecting certain stocks by introducing the measure.
In other quarters, the SEC received support for its action, including strong backing from leading US law firm Wachtell, Lipton, Rosen & Katz. In a memo, the firm praised the measure as a first step but demanded that more aggressive action be taken against abuse short selling and rumour-mongering. In particular, it asked the SEC to undertake a 45 day study of the markets to determine the extent to which manipulative short selling was taking place and to "fashion appropriate regulatory and enforcement responses", and, where appropriate, should coordinate its enforcement efforts with the Department of Justice and US Attorneys.
To read the SEC Emergency Order, click here.
To read the MFA / CPIC public statement, click here.
To read the statement from Wachtell Lipton, click here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
